What is a 1031 Exchange?

1031 Exchange Overview

A 1031 tax-deferred exchange enables investors to reinvest the proceeds from the sale of investment property in one or more replacement properties without incurring immediate federal (and state) capital gains taxes on the appreciated value. When the sale and purchase meet the 1031 exchange criteria, taxes are deferred until the newly acquired property is sold. This deferral strategy can be repeated through any number of exchanges until the tax liability passes into the individual’s estate upon death.

Section 1031 Requirements

Replacement property acquired in a 1031 tax deferred exchange must be “like-kind” to the property being sold. Like-kind means “similar in nature or character, notwithstanding differences in grade or quality.” A 1031 exchange may involve any of the following property types:

• Single Family Rentals
• Multi-Family Rentals
• Office Buildings
• Storage Facilities
• Raw Land
• Retail Shopping Centers
• Industrial Facilities

The general guidelines to follow in order for a taxpayer to defer all the taxable gain are as follows:

• The value of the replacement property must be equal to or greater than the value of the relinquished property.
• The equity in the replacement property must be equal to or greater than the equity in the relinquished property.
• The debt on the replacement property must be equal to or greater than the debt on the relinquished property.
• All of the net proceeds from the sale of the relinquished property must be used to acquire the replacement property.
• There are strict timeline and identification rules that must be followed for a 1031 exchange. First, the investor must identify replacement property within 45 calendar days of the close on the relinquished property. This identification must be in writing, and can follow one of three possible identification rules:
• 3-property rule: Up to three properties are identified no matter what their value.
• 200 percent rule: Any number of properties is identified as long as their combined fair market value (FMV) does not exceed 200% of the FMV of the relinquished properties.
• 95 percent rule: Any number of properties are identified no matter what the aggregate FMV, provided 95% of the value of the identified properties is acquired. Second, the investor must close on the identified replacement property(s) within 180 days from the close date of the relinquished property.
• Moreover, an independent third party must serve as a Qualified Intermediary (QI). The QI is required to hold the proceeds of the sale of the relinquished property until the proceeds are reinvested. There must also be a written “exchange agreement” between the investor and the QI which serves to protect the investor from having “constructive receipt” of the exchange funds during the exchange period. The QI’s role is to ensure these rules are properly followed and that the equity is preserved. IRC rules require the investor to have a QI to complete a 1031 exchange.

A 1031 exchange can be an effective tool for building wealth. However, investors must work with their professional tax advisors to meet the requirements of IRC Section 1031, as failure to comply with IRC Section 1031 or an unfavorable tax ruling may cancel deferral of capital gains and result in immediate tax liabilities, including tax penalties.

Further Information

This is neither an offer to sell nor a solicitation of an offer to buy any security. Such an offer may only be made by means of a private placement memorandum. Before we provide information regarding future DST offerings, properties and other details, we are required to obtain and discuss information about potential clients and their investment objectives.

*Obviously it is not realistic to identify all of the potential advantages or risks that an individual investor may encounter in a particular 1031 DST. Investors should carefully review any and all applicable prospectuses and or private placement memorandums prior to making any investment. Investing in alternative products carries a high degree of risk. Not all investors will be qualified to invest in 1031s and DSTs.  

This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor. DST 1031 Investments does not offer tax or legal advice.